As you are aware of, revenue recognition is a common term in the corporate financial management scenario. It is the tenet that determines specific conditions under which revenues are accounted.
The new revenue recognition is already in place and ready to go. The companies in the United States are expected to report their reviews according to the new standard, which goes by Accounting Standards Codification 606 (ASC 606).
The ASC 606 model is no longer news but a fact that companies must adhere. Most of the private companies are in the due process of implementation.
Can you relate to this? Is your company ready for adopting ASC 606? Are you still confused about the differences between the old and new revenue recognition principles? You can read here the essential concepts related to ASC 606.
What is ASC 606?
ASC 606 is an amalgamation of the principles put forward by Financial Accounting Standard Board (FASB) and the International Accounting Standard Board (IASB). This new revenue recognition is applicable for all companies registered in the US and companies outside the country will follow IFRS 15 issued by IASB. In fact, IFRS 15 and ASC 606 are fundamentally similar in their core concepts.
Why the new standard?
The previous revenue standard is complex to interpret and implement as there are couple hundreds of pieces of literature that contributed to the standard. The old standard (ASC 605) focus on few industries and transactions, but there is no guidance on revenue recognition for other industries. This gap in the standard makes revenue recognition requirements inconsistent across industries and transactions. This will make it difficult to compare revenue between similar industries or across industries.
For example, the old standards were insufficient for comparing a non-US company and US company which worked in the same industry. Moreover, the previous rules made it difficult for global organizations to report revenue and be on the same page.
Thankfully, the ASC 606 has addressed these faults the previous model and achieves the objective brilliantly. It provides an innovative framework to recognize revenue. ASC 606 has simplified the revenue reporting and the requirements to report as well.
With ASC 606, organizations are required to apply the new principle starting from 1st January 2018. In short, the new guidelines are applicable for public companies from 2018 and private entities from 2019.
Digging deeper into ASC 606
ASC 606 is, of course, a catalyst to change. The new revenue recognition mainly puts forward the theory ‘entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or service.’
One of the primary goals of this ASC 606 is to address the inconsistencies and drawbacks in revenue requirements. It improves comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. The preparation of financial statements is greatly simplified by this new revenue recognition model. Achieved by reducing the number of requirements.
The five-step approach helps an entity to recognize the revenue concerning the new revenue recognition principle.
- Identify the contract with the customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies a performance obligation
The major considerations in ASC 606
The first question that comes to a discussion is how far the new principle differs from the previous revenue recognition model. To understand it in a better way, you can consider the six major factors and how the new revenue recognition model influences it. Read here the major considerations for ASC 606.
- Pricing: It is one of the key considerations for revenue recognition in ASC 606. The discounts offered by company definitely impact the transaction price calculation. Here, any variable considerations applied to this price to calculate the final transaction price.
- Billing: As per the new norms, discount given in the invoice on any grounds will come under variable consideration and influences the transaction price. Therefore, the revenue recognized will be in sync with the discounts given on the invoice.
- Royalty Points: Sales and usage-based royalty is considered as a variable because the royalty is paid after a sale. It is calculated based on the expected-value method or the most-likely amount method based on the business scenario.
- Loyalty: Loyalty points are the customer option for additional goods and services for free or at a discount price in future. If loyalty points result in a material right, then it should be considered as a separate performance obligation.
- Rebates: Rebates payable for current purchases by a customer should be considered as variable consideration for calculating the transaction price of the sale. The transaction price should be adjusted based on subsequent changes in rebate.
- Sales compensation: Sales compensation consists of incentives and commission paid to salespeople. These costs are the incremental costs incurred in obtaining a contract. The cost should be capitalized and amortized over the period of the contract if the contract duration is more than one year. The cost can be expensed if the contract duration is less than a year.
How to prepare your company for ASC 606?
Listed here are a few factors that would help your company to prepare for the new revenue recognition principle:
- Collective effort: ASC 606 requires effort from all departments like IT, sales, product and legal, etc. and not finance and accounting issue.
- Identification of contract types: Identify and analyze the performance obligations and variable transaction price considerations and allow sufficient time for the same.
- Additional disclosure requirements: It is essential to examine and determine other disclosure requirements if necessary.
- Have a project plan: Prepare a detailed work-plan which includes critical activities and milestones, training requirements, etc. which will help you adapt to the new revenue recognition principle.
As part of encouraging collective effort, you can form an internal team to do an initial assessment concerning the new guidelines. The team should include people from all departments to analyze the impact of the new guidelines. This way, you can frame the strategy that is best suited for the new revenue recognition policy.
Challenges in the new principle
Every new model will have specific challenges and opportunities. Financial experts doubt that dual reporting and restatements can be complex to manage. One of the major challenges would be total system update on the nature of contracts and guidance related to the accounting treatment of performance obligations. Moreover, the new revenue model can influence other corporate functions as well. Plus, there can be a set of operational challenges as well as difficulties in implementing the new revenue recognition.
For exiting Apttus customers, Standav devised a three-step transformation framework to help them adopt the new standards at an accelerated pace. If you are interested, do reach out for a quick demo!